Micro Channels in Price Action Trading

Micro channels – a general interpretation

Generally, when we mention a micro trend line, we mean a trend line, which can be drawn on any time frame across from two to about ten bars, while the majority of bars are relatively small and either touch this trend line or form near it. In addition, the trend channel line can be placed along the opposite ends of bars. As a result, a very tight channel is created, known as a micro channel.

What is specific about these micro channels is, that unlike traditional channels, they have no pullbacks, or, in rare cases, pullbacks are tiny.

In case there is a large number of bars, bars with large trend bodies in the direction of the micro channel and also bars with tiny wicks, all this implies that the micro channel itself is strong and it is very likely that the first pullback will not lead to a trend reversal.

A micro channel usually is as long as ten bars. However, at times this channel may last for ten bars, followed by a tiny pullback, and after that it may continue for another set of ten bars. Regardless of how a trader may interpret such a situation (either as two micro channels, separated by a pullback, or as one large tight channel), he/she will usually trade it one and the same way. He/she will wait for any reversal attempt to fail (or in other words, a pullback to occur) and enter in the direction of the trend, as the latter continues to develop.

The environment where micro channels occur determines how they should be traded!

Bull and bear micro channels can occur both in uptrends and downtrends as well as in trading ranges. Both types of micro channels can be breached to the upside or to the downside.

Just as with any breakout, three possible scenarios can develop. First, the breakout can be real and can be followed by further trading in its direction. Second, it may turn out to be a failed breakout and be considered as a small climactic reversal. Third, the market may go in either direction, thus, the breakout gradually transforms into a trading range.

Market players will either enter in the direction of the breakout, because they anticipate more price action to follow, or in the opposite direction, in case they anticipate a fakeout. Traders will usually try to make a comparison between the strength of the breakout and the strength of the reversal attempt. In case one of these two appears to be plainly larger than the other, the trader will likely conclude that prices may go in that direction. In case there are signs of equal strength, the trader would better wait for more price action before making a decision.

If a bear micro channel appears during an uptrend, it can be considered as a bull flag or the last leg of a bull flag. A trader should look for a suitable signal bar and place a buy stop a few pips above its high price in order to enter on the breakout from that bear micro channel.

If a bull micro channel appears during a downtrend, it can be considered as a bear flag or the last leg of a bear flag. A trader should look to go short below the low price of an appropriate signal bar (a breakout to the downside or a pullback from this breakout down).

If the bull micro channel appears after a possible bottom in a downtrend, it may turn into a final flag in this downtrend, while the price may break out to the upside and not to the downside. What is more, this breakout may represent a sudden move (spike), that will mark the beginning of an uptrend.

If instead of a bear micro channel in a bull flag, this micro channel is a bull one forming during an uptrend, the first occurring breakout to the downside will probably fail, thus, it will be a pullback and many traders will go long there. If the bull micro channel consists of more bars, this makes it very possible that the breakout to the downside may not manage to reverse the uptrend.

Example

Let us imagine the following situation. If a micro channel in an uptrend consists of seven bars, it is quite possible that there may be far more buyers at or below the low price of the seventh bar than sellers. If prices move below this seventh bar, the latter produces a breakout to the downside from the channel. It is not very likely, however, this selling to last for more than 1-2 bars, because buyers will probably be anxious to go long on the first pullback. A large number of traders have probably been observing this seven-bar rally, lying in wait for any pullback, so that they can enter. They will probably go long below the seventh bar and above the high price of the bar, where the pullback occurred.

In case a bull micro channel appears during an uptrend, higher prices are more likely. Market players will usually strive to go long close to the middle area or the low price of the preceding bar.

It is also possible this micro channel to be very tight, so that if viewed on a higher time frame chart, it may appear as a spike. This spike may be followed by a wider channel, which produces the so called spike and channel type of trend.